This site uses cookies to store information on your computer. Some are essential to make our site work; others help us improve the user experience. By using the site, you consent to the placement of these cookies. Read our privacy policy to learn more.

Technology Considerations for Converting to IFRS

Lewis
A. Dulitz, vice president of accounting policies and research at
Covidien—a $10.7 billion health care products company with 42,000
employees in more than 60 countries—was part of a team that
implemented the necessary technology changes in Europe to help
Covidien convert to IFRS and led a similar team in the U.S. He
answered questions from the JofA about the experience and
provided advice for other companies to consider.

JofA:
Why did Covidien begin its IFRS implementation?

Dulitz: In
December 2008, Covidien announced it was relocating its principal
executive office from Bermuda—which reports in U.S. GAAP—to Ireland,
where local companies were required to file with the Irish
authorities in accordance with either IFRS or Irish GAAP. We were
preparing to file in accordance with IFRS beginning with our fiscal
2009 year-end for local purposes while maintaining our SEC filings
in accordance with U.S. GAAP. Recently a change in Irish law
extended our ability to use U.S. GAAP for our Irish filings, but we
have continued to prepare internally for IFRS implementation.

Dulitz:Our
director of Information Services is a key member of our core project
team. Once our accounting differences were identified, we discussed
the type of information that we would need from each application and
how best to extract the data (for example, systemic reporting vs. a
workaround). This approach helped us quickly narrow the scope of
impacted applications.

There
is not a lot of information on which applications are best suited
for IFRS—either with our existing ERP systems or new systems we were
considering purchasing—or what challenges you will face during your
implementation. The key feature to consider is flexibility. Most
companies will continue to have the requirement to report U.S. GAAP
results for a transitional period, so companies must figure out how
to best layer on IFRS information without compromising the integrity
of their U.S. GAAP data.

We
also used a publication by Ernst & Young to compare differences
in our inventory listing of applications and planned purchases. This
publication highlights certain IFRS “gotchas” in various
applications like Oracle, SAP and PeopleSoft.

JofA:
Can you give a few examples of systems that were impacted? (See
Exhibit 1 below for a summary of examples.)

Dulitz:Fixed-asset
ledger: Let’s
say you own a building with a historical cost of $40 million. Most
U.S. companies would account for the building on a composite basis,
meaning one asset record in the fixed-asset ledger with one useful
life, typically 40 years. The theory behind componentization is that
significant parts of large assets like buildings or manufacturing
equipment have different useful lives. This is akin to a cost
segregation study for tax reporting.

In
the example of the owned building, it is not probable that the roof,
heating and air conditioning system or elevators will last 40 years,
so they will be identified separately from the building structure,
assigned a relative fair value and their own useful life. The
resulting income statement impact is accelerated depreciation
expense as the asset is being depreciated over a shorter aggregate
useful life. We approached componentization by looking at our
historical data to evaluate what a component is. This process
involved extracting millions of lines of data and segmenting the
data into different asset value ranges. We then met with our subject
matter experts to agree upon the definition of a component and align
useful lives. The next challenge was to determine what system and
process modifications should be made.

Systems
considerations for fixed assets include:

Does
your system limit the total number of fixed-asset records?

Will
you be able to systemically calculate

incremental
depreciation expense for your opening balance sheet assets that
you componentize, or will you use Excel?

How
will you reflect your adjusted carrying value in subsequent
years?

Do
you plan on embedding controls in your system to prevent data
input errors (for example, components being assigned a useful
life of a composite asset)?

How
will you ensure that all components to an asset that is impaired
are properly derecognized?

How
will you account for impairment reversals?

Process
considerations include:

If
you have multiple fixed-asset systems, how do you achieve
conformity?

How
will you align useful lives and definitions of
components?

How
does componentization affect your repairs and maintenance
policies?

Research
and development (“R&D”) also was impacted. In
the health care industry, most U.S. companies expense R&D costs
until regulatory approval is received. IFRS views the accounting for
the “R” and the “D” differently. Research costs are expensed, but
certain costs during the development phase are eligible for
capitalization at an earlier point than under U.S.
GAAP—technological feasibility (the ability to produce a product
that will generate cash flow that is probable and costs reliably
measured). This change complicates the process for many companies as
the current accounting under U.S. GAAP is simple as almost all
costs, regardless of type, are expensed throughout the development
cycle. Internal alignment must be reached as to when technological
feasibility occurs and what types of costs are eligible for
capitalization. We modified our product development system to
accommodate an IFRS life cycle.

Share-based
compensation was another focus area. There
are many differences with respect to share-based compensation
between IFRS and U.S. GAAP, but I will focus on graded vesting. If
you think about a simple three-year option grant, most U.S.
companies straight-line the compensation expense over the vesting
period. IFRS views the grant as three separate instruments each with
its own fair value and amortization period. It is very similar to
the componentization concept for fixed assets.

From
a systems perspective, grants will have to be split into individual
tranches for each employee as well as a fair value attributed to
each tranche, which may differ from your U.S. GAAP fair value as the
underlying assumptions used to value an option will change (term,
volatility, forfeiture rate, etc.). Companies will have to evaluate
whether their current software can accommodate IFRS reporting or if
an offline work-around is required. We worked closely with our
external service provider to enable systemic reporting.

Dulitz:Our
consolidation system. Our goal was to have system-generated
IFRS-compliant financial statements. We designed reporting within
our consolidation system, Hyperion Financial Management, to generate
IFRS financial statements at a consolidated and individual
legal-entity level as well as reports by individual IFRS difference
to facilitate automatically populating our footnotes. Whether you
are reporting on an individual entity or consolidating 100 entities,
you have to decide how to capture the differences (gross vs. net),
where the quantified adjustments will reside (inside the ledger or
consolidation tool or outside) and what your approach will be in
Year 2—will your adjustments roll forward, or will you have to add
Year 2 adjustments to Year 1 adjustments?

JofA:
How did you approach training?

Dulitz:We
did not expect every person in our finance organization to be an
IFRS expert. We leveraged our existing U.S. GAAP subject matter
experts and created our own Web-based IFRS checklist focusing on our
industry, company and IFRS 1 (First-time Adoption of IFRS)
elections. For completeness, we wanted our field controllers to
answer questions to assist in the identification of IFRS differences
and leverage the reporting technology within the tool to improve the
effectiveness of our core team’s review. For example, reports could
be generated by individual entity, entity type (finance company,
manufacturing, etc.) or IFRS difference (pension, restructuring, etc.).

JofA:
How much time should companies budget for their implementation?

Dulitz:In my
experience and speaking with some of my European colleagues, most
companies compressed their implementation into 18 to 24 months. The
EU only required one year of comparable financial information for
initial IFRS filings. It appears the SEC will require U.S. companies
implementing IFRS to provide two years of comparable information.
Although much of the work is upfront, this still results in
additional analyses and one more year of audited financial
statements. For companies that want to have parallel reporting of
IFRS and U.S. GAAP by 2013, start now.

Many
companies have not and will not start until there is a date certain
set by the SEC, which may result in shorter implementation windows
for these companies and increased cost.

JofA:
Is there any way to cut down on costs?

Dulitz:Identify
what is a nice-to-have vs. a need-to-have for your company. Your
documentation must be accurate and auditable. It is easier if it is
system-generated, but cost is a factor that may lead companies to
manual solutions in the near term.

Be
realistic with your project plan. Every system does not need to be
transactional on Day 1. You can continue U.S. GAAP procedures as
long as you know where your differences lie, how to quantify the
differences and adjust your financial statements accordingly. Say
under U.S. GAAP your fixed assets are $20 million, but under IFRS it
is $16 million. How will you reflect that $4 million? Where will you
post it? Offline in Excel? Or ERP? What do your records support, the
$16 million IFRS balance or the $4 million difference between IFRS
and U.S. GAAP? How do you plan to archive that information?

JofA:
Any other advice?

Dulitz:Ask
your external service providers what their level of IFRS knowledge
is and about their internal road map. Understand where they are from
an educational and systems perspective. In particular, your
actuaries are critical to the process. There are significant
differences in accounting for pensions, acquisitions, business
valuation for impairment testing, and share-based compensation. A
lot of smaller service providers might not have even started to
develop systems or expertise within their office. Most accountants
and actuaries will be learning IFRS in real time. Start your
diligence to ensure you have the right partners involved,
communicate your expectations, and obtain their commitment to meet
your needs.

Alexandra
DeFelice is
a JofA
senior editor. To comment on this article or to suggest another
article, contact her at adefelice@aicpa.org or 212-596-6122.

Latest News

FEATURED VIDEOS

The challenges of the new lease accounting standard have been pervasive to say the least. In this free, independently-written report, you'll learn effective adoption strategies as well as resources for easing the transition to the new standard.